3 Smart Tax Tips for Retired Investors


OVER THE DECADES, successful investors gain valuable experience with basics like spreading their money around, avoiding fads and skirting annual taxes. But as soon as they retire it’s a whole new game, emphasizing retirement income over growth and deciding how much they can safely withdraw each year. And taking care to pay as little as possible in taxes.

It’s a juggling act. Some withdrawals are taxed as income, others at the lower long-term capital gains rate. Some – from Roth accounts – aren’t taxed at all. In a progressive system, income tax rates vary depending on income and smart investors can control income to get the lowest tax rate they can, especially if they also have a pension.

Taxes are not an easy subject to love and even people who earn a living maneuvering the intricacies of the tax code can spend a lifetime learning how. But experts say there are a few key things anyone in or near retirement ought to know, though the groundwork is best laid years before:

Think about your long-term goals.
Follow a budget.
Manage your assets.

Think About Your Long-Term Goals
Nowadays, someone retiring at 65 should plan to live for 20 years or longer, says Tenpao Lee, professor of economics at Niagara University. So some longstanding thinking about investment withdrawals is out of date.

For example, successful retired investors have long tried to keep withdrawals from tax-favored accounts like individual retirement accounts and 401(k)s to the minimum required, leaving as much in the accounts as possible to benefit from tax-deferred compounding.

But with a longer life expectancy, Lee says it may make sense to exceed the minimum each year since taxes will have to be paid anyway.

“In contrast to a traditional view, to take minimal distribution may not be the best strategy, as you have to pay tax eventually,” he says. “If you take minimal distribution initially you may end up paying more tax in the later years.”

Getting the tax payments out of the way can also make things easier on heirs, he says. He recommends withdrawing all funds from these retirement accounts over the first 20 years of retirement, even if the rules would require a slower pace. For the first 10 years, money not spent can be reinvested in the broad-market through index funds, and in the second 10 years it can go into more conservative holdings, Lee says.

Follow a Budget
Randy Tarpey, a certified public accountant at Sickler Tarpey & Associates of Tyrone, Pennsylvania, urges retirees to withdraw a consistent amount every month rather than to take a lot some months and less in others, as needed. Budgeting imposes discipline and keeps tax bills relatively predictable.

To avoid a spike in taxes from an unusual withdrawal, he recommends that purchases like a new car or home improvement be funded from a home equity loan. Taxes on the required minimum withdrawals on retirement accounts can be avoided if those funds are used for charitable donations, he says.

Retirees should look at how they will produce income over the long term, to avoid surprises like big tax bills or retirement income shortfalls, says Josh Trubow, an advisor with Sensible Financial Planning in San Diego and Waltham, Massachusetts.

“This means outlining what income sources are available, when they begin and end, and how they may be taxed,” he says. “It’s necessary to do this income mapping for all retirement years and not just the current year or year you retire.”

Keeping income steady can minimize taxes over time by keeping the investor in the same tax bracket, Trubow says.

“Draws from Roth accounts (which are tax free) or withdrawals from savings can be used to help minimize taxable income,” he says. “Draws from a 401(k) or traditional IRA (both taxed as income) can be used to realize or accelerate income in years where your tax bracket is lower.”

In other words, take just enough from the accounts taxed as income to stay in a lower taxation bracket.
Manage Your Assets
While many retirees hope to set up a dependable income with no fuss and no muss, a long retirement may require tweaks.

Beth Logan of Kozlog Tax Advisers in Chelmsford, Massachusetts, points out that the standard deduction is now $24,000 for a married couple filing a joint return. That means a couple earning $5,000 in interest, dividends and capital gains could take an additional $19,000 from high-tax accounts like traditional IRAs and 401(k)s without paying any tax.

And even more could be withdrawn while staying in the lowest income tax bracket, 10 or 12 percent. Some of these withdrawals, if not needed right away, can be reinvested in taxable accounts to assure a low long-term capital gains rate on future earnings.

Investors should make the most of the years between retiring and turning 70, says Aaron H. Parrish, president of Level Wealth Management in Greensboro, North Carolina. At that point many will start receiving Social Security if they have delayed to get a larger benefit.

And at 70, investors face required minimum distributions from traditional IRAs and 401(k)s. These events make it harder to control income to minimize taxation.

“If selling for gains in a brokerage account, try to keep your taxable income below $39,375 if single or $78,750 if married filing jointly,” he says. “Long-term capital gains have a 0 percent tax if your taxable income is at or below these thresholds.”

A good option when keeping below these thresholds, he says, is to sell investments from the taxable accounts and invest in a Roth account, which allows tax-free withdrawals. That way there’s no tax on the sale and no tax on future gains.